The first steps toward purchasing a new home can be overwhelming. After deciding on your budget, preferences, and real estate agent, you then need to seek out lenders for your mortgage, who will ask about your down payment and other income information. A down payment is the percentage of the purchase price that you will pay upfront. Saving for a down payment is a huge factor in determining the price of the house you can afford, what you end up owing the lender, and how much interest you end up paying.
How much should you be saving for a down payment?
The mortgage lender provides the money for the remaining house payment after deducting the down payment. Contrary to what most people think, choosing a larger down payment isn’t always the best option—some loans backed by the federal government offer more flexible alternatives. What you choose, or can, put down depends on your financial situation and goals.
Pros of a Larger Down Payment
Many conventional loans require private mortgage insurance (PMI) if you put down less than 20% of the total value. Once you’ve reached 20% equity in your home, you no longer need PMI. Down payments of at least 20% will save you a monthly PMI payment. Additional benefits of a larger down payment include:
- More equity in your home will make you a larger profit when it comes time to sell, especially if your home’s value increases over time. You can also invest or borrow from your home’s equity and use that money for other financial endeavors.
- A lower monthly payment on your mortgage will help you save money. You could use the extra money to invest in updates your house may need so that it contributes to the overall value.
- Lower interest rates will be offered since larger down payments pose less of a risk to lenders.
- A lower debt-to-income (DTI) ratio will benefit you for borrowing in the future. Lenders and credit card companies look at DTI to determine what you get approved for.
Saving for a Down Payment: Pros of a Smaller Down Payment
You may qualify for a lower down payment if you are a veteran, a first-time homeowner, or your income meets a certain threshold. Additionally, there are down payment assistance programs that you can learn more about through your real estate agent or bank.
- Buy a home sooner with a smaller down payment. Just because someone doesn’t have enough to put down, doesn’t mean they won’t be able to afford the monthly payments.
- Save your money for other investments such as maintenance and repairs to the home. This will ensure it’s going towards your initial investment and help you receive a profit once you decide to sell.
- Have an emergency fund for other unexpected life events. Investing it back into your home may not be necessary or the right option for you and the health of your finances.
Other Factors to Consider When Saving for a Down Payment
Homeownership is an exciting adventure that comes with many other expenses that we often overlook. The factors to consider when saving for a down payment are just the beginning of taking on a bigger responsibility. As you start to consider purchasing a home, keep in mind the following factors to help you be more prepared and efficient with your money:
- Closing costs are a variety of fees that accumulate as you close on your loan. Your real estate agent will help you estimate what these might be and you may even be able to fold them into your loan which you will pay monthly. The fees cover items such as the appraisal, inspection, application, and credit report costs. Closing costs range from 3%-6% of the purchase price.
- How much you can afford will help you determine what your down payment should be. Many financial experts suggest purchasing a home that’s two to three times more than your household income. Exceeding this price may cause you to go “house poor” where all of your monthly income goes towards your house, making it difficult to purchase other important items.
- Avoid draining your savings account so that you have emergency funds, are able to put money back into your house, and have an overall cushion in case anything unexpected arises. It’s hard-earned money that you shouldn’t have to get rid of entirely when purchasing a new home.
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